In re Novell: Delaware Court of Chancery Finds Potential Bad Faith by Target Board
The Delaware Court of Chancery denied a target company board's motion to dismiss, finding that the board's preferential treatment of one bidder over another made the plaintiff-stockholders' bad-faith claim against the board reasonably conceivable.
On January 3, 2013, the Court of Chancery of the State of Delaware denied in part a motion to dismiss brought by the defendant directors of target company Novell, Inc., Novell's buyer Attachmate Corporation and a minority stockholder of Novell, Elliott Associates LP. The Court in In re Novell, Inc. Shareholder Litigation ruled that the plaintiff stockholders had made a reasonably conceivable claim that the board had breached its duty of care and acted in bad faith by giving preferential treatment to the eventual buyer Attachmate over another bidder for Novell who had made a comparable offer.
The class action case arose from the acquisition of Novell by affiliates of Attachmate, itself a portfolio company of three private equity firms (for a summary of the November 2010 merger agreement, see PLC What's Market, Attachmate Corporation and Novell, Inc. Merger Agreement Summary). Under the terms of the acquisition, Novell stockholders received $6.10 per share in cash. On the same day as it entered the merger agreement, Novell also entered into a purchase agreement to sell a portfolio of patents, pending-patent applications and lapsed patent applications to a consortium of technology companies organized by Microsoft Corporation. The purchase price payable by Attachmate was financed in part with an equity commitment by Elliott Associates, a stockholder of Novell who had been pressing for a sale. Under an agreement with Attachmate, Elliott Associates exchanged a portion of its stock in Novell for an equity interest in Attachmate's ultimate parent entity.
In the months leading up to the agreement with Attachmate, the board of Novell had conducted a fulsome market check in which its financial advisor contacted over 50 potential buyers. Novell entered into non-disclosure agreements with more than 30 of those contacted and pursued further discussions with five bidders who made significant offers, including Attachmate.
In August 2010, the board of Novell requested that Attachmate and one other bidder, a private equity firm referred to as "Party C," make their best and final offers. This followed a request that Attachmate had made to Novell to speak with a broader set of financing sources, including Elliott Associates. Novell granted that request to Attachmate without offering Party C the same opportunity. On August 27, 2010, Attachmate offered $4.80 per share while Party C offered $4.86 per share, in spite of the extra financing assistance that only Attachmate had access to. After considering various more proposals over the ensuing weeks, Novell granted Attachmate exclusivity and continued discussions with it alone, which led to a revised offer by Attachmate of $5.25 per share in cash. On the same day that Attachmate submitted that offer, Party C, in spite of its exclusion from direct discussions with Novell, made its own revised and unsolicited offer of $5.75 per share.
After receiving these offers, as well as a revised offer from Microsoft for Novell's patent portfolio, Novell's board decided to pursue discussions with Attachmate and Microsoft. Novell eventually reached an agreement with Attachmate on a final purchase price of $6.10 per share.
The merger agreement Novell entered into with Attachmate included three customary deal-protection measures:
A no-shop forbidding Novell from soliciting new bids.
A five-day matching right for Attachmate.
A break-up fee equal to 2.7% of Novell's equity value (without deducting the value of Novell's cash holdings), or 8% of the $750 million actually paid by Attachmate.
Key Litigated Issues
The class action claim brought by Novell stockholders against Novell's board, Attachmate and Elliott Associates made several allegations, all essentially amounting to a charge that the Novell board, with the cooperation of Attachmate and Elliott Associates, had failed to meet its Revlon duties to maximize stockholder value. The charge included allegations that the board knowingly favored Attachmate by:
Allowing Attachmate to team with Elliott Associates, without giving Party C a similar opportunity to team with strategic partners.
Granting Attachmate exclusivity before asking Party C if it would be willing to increase its bid.
Making no effort to negotiate with Party C following Party C's second proposal.
Failing to let Party C know that Microsoft was prepared to purchase the patent portfolio, which would make more cash available for the acquisition.
Agreeing to the deal-protection measures in the merger agreement.
The defendants moved to dismiss the claims, denying that any breach of fiduciary duty had occurred. The Novell board added that even if it did breach any of its fiduciary duties, those breaches only amounted to breaches of the duty of care, for which the directors would be exculpated from liability under the Section 102(b)(7) provision in Novell's charter (for an example of this exculpation provision, see Standard Document, Certificate of Incorporation (Short-form DE): Section 7). The plaintiffs argued, however, that the breaches were committed in bad faith, for which exculpation is not available. The bad-faith claim was based primarily on the allegation that the Novell board had knowingly favored Attachmate over Party C.
The Court of Chancery's decision was made at the pleading stage regarding whether to grant or deny the defendants' motion to dismiss. The evidentiary record at this stage was limited and the plaintiffs needed only to meet a "reasonably conceivable" standard, under which the Court found that the plaintiffs had met their burden regarding their claims of favoritism of Attachmate over Party C.
The Sales Process
The Court held that absent a reasonable explanation from the defendants, they and their financial advisor could be found to have treated Party C in a way that was both adverse and materially different from the way they treated Attachmate. Party C could not team with any other interested bidder and was not informed of the patent-portfolio sale, which would have provided a substantial amount of cash at closing. Because Party C's offer was "roughly comparable" to the price Attachmate was offering, it is reasonably conceivable that it would have offered significantly more than Attachmate had it equally known that it would have access to the proceeds of the patent-portfolio sale. The fact that it was not given the same information potentially amounted to a failure by the board to achieve the highest price reasonably obtainable.
As the Court explained, an independent and disinterested board is not necessarily required to treat all bidders equally under all circumstances. It may treat bidders differently if the target stockholders' interests justify doing so. In this sales process, for example, the board could have been justified in negotiating exclusively with Attachmate if Attachmate had fewer due diligence needs or more certain financing than Party C. The Novell board might also have been concerned that the process had been taking too long and that it risked losing the Attachmate-Microsoft combination if it continued negotiating with Party C. Any of these possibilities may be proven on a more developed record. However, at the pleading stage, there was no evidence to support any of these defenses. It was therefore reasonably conceivable that the board materially and unjustifiably treated a serious bidder for the target company differently than it did the ultimate buyer.
The Bad Faith Standard
Having adequately pleaded a claim that the board breached its duty of care, the plaintiffs had to also establish that the board committed that breach by acting in bad faith. Overcoming the presumption of good faith required demonstrating that the board's actions were "so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith." Because the Court had no explanation on the record for the Novell board's conduct toward Party C, it found that the plaintiffs met the required standard. The board's failure to continue discussions with Party C or inform it of the patent-portfolio sale, while keeping Attachmate fully informed, was enough at the pleading stage to support an inference that the board's actions were taken in bad faith.
The Deal Protections
The Court granted the defendants' motion to dismiss the count charging that the deal-protection measures in the merger agreement unduly favored Attachmate. The Court noted that the measures are customary and well within the range permitted under Delaware law. Relying on the usual slate of previous Court of Chancery opinions addressing deal protections (in particular, In re 3Com, In re Dollar Thrifty, In re Cogent and In re Toys "R" Us), the Court found all three measures, individually and taken together, to be reasonable. The Court emphasized that the proper measure of the break-up fee is its percentage of the equity value (without reducing the target company's cash holdings), not the percentage of the dollar amount that the buyer is paying at closing.
The Novell board may yet prove that it was justified in carrying on negotiations with Attachmate to the exclusion of Party C. But the decision still demonstrates the necessity to conduct a robust market check that keeps all serious bidders on equal footing, absent a reason to favor one bidder over another. It is not hard to advance a good reason, such as if one bidder has more certain financing or fewer conditions to a deal. Without such a reason, however, the Novell decision demonstrates that the failure to negotiate evenly with two bidders can support not only a breach of the duty of care, but a finding of bad faith.